Carve Out Process: How To Carve Out A Company
What is the company carve out process?
The company carve out process is when a company separates off a division or subsidiary, which becomes a standalone company.
What happens to stock in a company carve out?
In a company carve out, also known as a carve out IPO or equity carve out, the stock in the new company is sold via IPO and becomes publicly available.
How long does a company carve out take?
The company carve out process usually takes 6-18 months. However, with advanced divestiture data room software like Ansarada, the process can be dramatically fast-tracked.
See also: Corporate Divestiture Process
Earn out vs carve out in acquisitions
Carve outs and earn outs are both processes that relate to mergers and acquisitions but they’re very different. A carve out is when a company offers shares of a business unit for sale via IPO, making it a separate company.
An earn out is a future payment that is contingent on the selling business satisfying certain milestones or performance thresholds. Earn outs are notoriously litigated as the buyer and seller often disagree as to whether a milestone was achieved.
Carve out IPOs in detail
Carve out IPOs can generate significant capital for the new company or its parent entity. However, these potentially large returns are dependent on market conditions.
IPOs can consist of primary and/or secondary offerings. With primary offerings, the proceeds go to the carve out business (ListCo—that is, the newly created company). In this scenario, ListCo uses the IPO to generate funds and put equity on its balance sheet.
Secondary offerings in the company carve out process involve the sale of shares in ListCo, with the parent receiving the cash. Secondary offerings are therefore a type of divestiture, not dissimilar to a company spin off.
How to carve out a company in 7 steps
1. Define the deal parameters
As with any major transaction, it’s important to determine early on exactly what is and what isn’t included in the deal, as well as the desired outcomes of the transaction. Part of this will be determining how ListCo is going to operate, as well as any assets to be transferred from the parent company.
2. Follow a carve out due diligence checklist
It’s critical that this part of the process is thorough to avoid hidden costs, such as new license/lease costs that ListCo will need, so it’s highly recommended to follow a carve out due diligence process checklist.
Everything from IT to HR, finance to sales and marketing must be addressed so that there’s a clear picture of exactly how each business will operate and with what resources post deal.
3. Agree to an appropriate setup timeframe
It's important to build a dependency schedule that gives a realistic view of the time it will take to complete the transition. Extending the Transition Services Agreement (TSA) timeframe during the transition can be very costly. Developing a realistic timetable will reduce the pressure of business setup during a stressful time.
4. Decide whether to clone or go it alone
"Clone and go" is a systems setup strategy frequently used to accelerate the operational independence of the new company. In essence, it replicates the parent company’s processes, systems, applications, data, policies and/or practices, and uses that clone as a ‘plug and play’ framework for getting started post deal. However, there are instances when going it alone and starting from scratch makes more sense for the new company.
5. Determine your leadership
EY research between 2002 and 2017 into 124 global spin off transactions revealed that most of the SpinCos that were successful had named a candidate from the parent company as either CEO or CFO or both. While this data relates to the company spin off process, the effect of having known leadership within a carved out company is likely to be similar. EY defined success as delivering a total shareholder return one year after the spin that was higher than the parent company’s within the same period before the transaction.
6. Apply change best practices post deal
Although a carve out presents some unique challenges, there are of course best practices relating to change management that can be applied. Don't neglect the importance of credible, ongoing communications and the benefits that a positive change narrative can bestow. Consider culture, employee engagement and other organizational change priorities that will set the new company up for success.
7. Act quickly
The same EY spin off research also found that slow transactions generated negative total shareholder returns, whereas deals executed within 7 to 16 months had positive returns. On this basis, it’s highly recommended to invest in technology to streamline and optimize the carve out process.